EIU Global Forecasting Service

Oil prices fall significantly after the OPEC deal to keep production down breaks apart

Moderate probability, Moderate impact; Risk intensity =

January 24th 2018Introduction

OPEC producers and Russia agreed to extend their production cuts throughout 2018 at the end of November. After that, the quota system is expected to be wound down only gradually. However, there is a risk that the OPEC deal will break down.

Analysis

The oil exporters organisation has lost market share to non-OPEC producers, particularly the US, and during 2018 member producers may calculate that their strategy has not worked, choosing to revert to their previous policy of preserving market share, come what may. Alternatively, rising political tensions between members of the Gulf Co-operation Council related to the Saudi-led embargo of Qatar could potentially erode OPEC countries' willingness to work together to rebalance the oil market. In addition, Russia's participation has become increasingly important to the success of the deal, but its government's willingness to commit to the end-2018 extension of cuts appeared to waver ahead of the November meeting. If Russia were to pull out of the agreement early - for example, owing to a breakdown in its partnership with Saudi Arabia, or out of a desire to boost its revenues from natural resources - this could also cause the broader deal to fall apart. If the taps are turned back on, roughly 1.8m barrels/day of additional production would come back on the market. This would cause prices to plummet. Although this would support slightly higher consumption, it would not be enough to offset the influx of new production, and prices could fall back to previous troughs of around US$30/barrel. Cheaper oil will support economic activity in countries that rely heavily on energy imports or energy-hungry industries, although the shockwaves of the impact on producers would be felt globally. Oil producers (including the US and Canada) would suffer greatly from a downturn in investment, feeding through to economic demand. Countries that rely heavily on oil exports - primarily the Gulf, but also Russia, West Africa and some parts of Latin America - face a second round of spiralling current-account and fiscal deficits.

Conclusion

Coming closely on the tail of the 2014-16 downturn, they are less capable of weathering the storm, and some countries would face serious balance-of-payments shocks. Developing nations, including Nigeria and Angola, would face serious debt distress, and possibly also political and social instability.